Home Stock The psychology of the stock market bubble

The psychology of the stock market bubble


I don’t know if the stock market is really forming a bubble about to burst.

But I do know that many bulls are fooling themselves when they think a bubble can’t happen when so many of us are worried about a bubble. In fact, one of the distinguishing features of bubbles is that widespread concern.

This seems counterintuitive. You would think that a bubble is most susceptible to formation and then burst when traders are not aware of that possibility. But you may be wrong.

It’s important for all of us to be aware of this mentality, but especially if you are retired or about to retire. That is because, in that case, the duration of your investment will be shorter than that of younger people, and therefore it is unlikely that you will recover from the deflation of the market bubble.

To gauge the prevalence of current concerns about bubbles, review the accompanying data chart from Google Trends. It charts the relative frequency of Google searches based on the term “stock market bubble.” Note that this frequency has recently risen to a much higher level than at any other time in the past five years.

This broad concern is entirely consistent with the formation of bubbles, according to a definition proposed a few decades ago by Robert Shiller, Yale finance professor and Nobel Prize winner. According to him, the bubble is “a market situation in which bullish news drives investor enthusiasm, which spreads in a sentiment that spreads from person to person, leading to a class of top investors. increasingly, people, despite doubts about fundamental values, lured partly through the jealousy of others’ success and partly through the excitement of a gambler. “(I italicized the phrase above, not Shiller.)

Note that overpricing acknowledgment is an integral part of the definition.

This recognition was certainly there in the weeks and months before the booming Internet bubble in March 2000. In the early and mid 1990s, as you may recall, could justify the high prices. while maintaining a straightforward attitude. But that was less and less as prices continued to soar in the late 1990s, and especially when a number of dot-com companies listed their stock at a hefty valuation despite having no assets or sales or a business plan.

However, instead of reacting by taking some chips off the table, many people are starting to comfortably admit that a bubble is forming. They no longer try to justify the higher price tag based on fundamentals, but instead begin to justify it in terms of market dynamics. Prices will continue to rise as FOMO attracts more and more investors to join.

Of course, there is no shortage of present analogies. Think of dogecoin, which was created as a joke and has no fundamental value. As one The Wall Street Journal’s recent article outlined, dogecoin “serves no purpose and unlike Bitcoin, there is no limit to the number of coins in existence.” However, investors are flocking to it, for no apparent reason other than that it has gone up too much. Billy Markus, the co-creator of dogecoin, was quoted in the Wall Street Journal article that “This is ridiculous. I have yet to see anything like it. It’s one of the things that once it starts going up, it can keep going up ”.

Needless to say, things don’t go up forever. However, those who continue to invest in such an environment do so on the tacit assumption that they will be able to realize it, before the bubble is about to explode – and thus be able to leave the party in front of others. . However, this is a dangerous illusion; Not everyone can be the first to leave the party.

The bottom line? Not only is it a reason why a bubble doesn’t form, the current widespread concern about a bubble could actually be a reason to worry that it might happen. Please note.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert’s rating Subscribe to investment newsletters to pay a fixed fee to be audited. He can be contacted at [email protected]

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